Transcription
Welcome back to the channel everyone. Thank you so much for joining me today. I'm so glad you're here.
My last video about Japan's economic troubles did really really well. You showed a lot of interest in that video and I appreciate it. So, I thought I would share another update and uh I have to say I don't have good news, but nevertheless, it is worth discussing.
As you may know, if you watch my videos, I report on this quite often. Japan has been considered one of the greatest financial anomalies in modern history. It accumulated the largest government debt in the developed world, which is more than twice the size of its entire economy. But investors from around the world continued lending to Tokyo at virtually zero interest rates. Economists often describe this as the quote unquote Japan miracle, which um is sort of an argument that Japan had somehow found a way to sustain enormous debt without suffering the consequences that other countries in a similar situation would face.
But that era is coming to an end. This week, Japan's government bond market delivered its strongest warning signal in nearly three decades. The benchmark 10-year government bond yield climbed to almost 2.9%, which is the highest level since 1996, while 30-year bond yields surged above 4%. For most countries, those numbers might seem quite ordinary, boring, nothing to write home about. But for Japan, they represent a dramatic shift. Investors are beginning to question whether the world's most indebted major economy can actually continue financing itself as borrowing costs continue to rise. The answer matters far beyond Japan, by the way, because its financial system is deeply connected to global markets, including the United States market.
Following the collapse of its asset bubble in the early 1990s, Japan spent decades battling deflation, weak growth, and stagnant wages. To revive the economy, the Bank of Japan launched one of the most aggressive monetary experiments in history. Interest rates were pushed below zero and the central bank purchased enormous quantities of government bonds through quantitative easing until it owned more than half of the entire government bond market. Okay, so that allowed Tokyo to borrow extraordinary amounts of money at almost no cost at all and it enabled public debt to exceed 200% of GDP without triggering a fiscal crisis. That entire system however depended on one assumption and that assumption is the interest rates would remain extremely low indefinitely. Well, today that assumption is rapidly unraveling.
The first reason is the return of inflation and we're going to go through the main reasons here. So, first let's cover the return of inflation. For many years, Japan struggled to generate any meaningful price increases despite massive monetary stimulus. Well, today higher energy prices as the result of the US and Israel's war against Iran, rising import costs, and stronger wage growth are finally feeding into consumer prices. The Bank of Japan expects businesses to continue raising prices. And so that suggests that inflation may prove more persistent than policy makers initially believed. As inflation expectations rise in Japan, investors naturally demand higher yields uh to preserve the purchasing power of their investments. So, they're going to want more money in return for their investment.
Now, the second concern is Japan's fiscal policy. Prime Minister Senate Takayichi has proposed a massive long-term spending program that is worth roughly 340 trillion yen or about $2.3 trillion spread over the next 14 years. Supporters argue that these investments are essential to strengthen Japan's economy, its infrastructure, and national security. Now, bond investors uh don't really agree with that position. They're asking who will finance this additional spending when the country already carries the largest debt burden in the developed world. Who's going to pay for it? Well, every increase in borrowing becomes far more expensive once interest rates begin rising.
And clearly the uh experts understand that perhaps the greatest concern is the credibility of the Bank of Japan itself. Last month, the central bank raised its benchmark interest rate to 1%, which uh is sort of the continuation of its gradual exit from decades of ultra loose monetary policy. Yet, many investors believe the Bank of Japan remains too cautious and risks allowing inflation to accelerate. So, effectively, they're saying the Bank of Japan is not doing enough to address inflation concerns. At the same time, the Japanese yen has fallen to its weakest level in roughly 40 years despite repeated government interventions designed to support the currency.
Now, if you're interested about the collapse of the yen, several days ago, I uploaded an entire video on this, an entire video dedicated to the collapse of the Japanese currency and the consequences that it has, not only for Japanese economy, but also for the global economy, including the US economy. Make sure that you watch that video next if you want to get the full picture.
Now, normally higher bond yields actually strengthen a country's currency because investors receive higher returns. But instead, both Japanese government bonds and the yen have weakened simultaneously this time, which is very unusual. And um many experts believe that this is an unusual combination that suggests investors are becoming increasingly concerned about Japan's long-term fiscal outlook.
These developments that I just described very briefly have revived fears of what economists call fiscal dominance. This occurs when government debt becomes so large that the central bank hesitates to raise interest rates because doing so would dramatically increase government borrowing costs. Instead of focusing solely on controlling inflation, policymakers may feel pressure to keep interest rates artificially low, which would in turn allow inflation to reduce the real value of government debt over time.
Now, does that sound familiar? With the $39 trillion in national debt here in the United States and counting, that should sound very, very familiar to us. But we will leave that aside and discuss in another video with an expert in an interview. I think that would be a really really fascinating interview. So definitely stay tuned if you're interested.
So while this strategy may temporarily ease pressure on government finances, it risks undermining confidence in both the currency and the bond market. The danger is that once investors begin suspecting fiscal dominance, a self-reinforcing cycle can emerge. As confidence weakens, investors demand higher yields to compensate for greater risks. Greater risk, greater return, right? So higher yields increase government interest payments. They worsen the fiscal outlook and they also require even more borrowing. That deteriorating outlook pushes borrowing costs higher still and creates what many economists describe as a vicious cycle.
Several market strategists now believe that if Japan's 10-year government bond yield rises above 3%, which it appears to be on track to do. Investors could begin seriously questioning the country's long-term debt sustainability. The implications extend far beyond Japan, of course. And remember, this is about sentiment, right? Markets are very much fed by sentiment. And so if investors start questioning, well, can Japan actually handle this? It is already a really, really bad sign.
So the implications extend far beyond Japan. Of course, Japanese pension funds, insurance companies, and financial institutions collectively own trillions of dollars in overseas assets, including one of the world's largest holdings of US Treasury securities. For many decades, Japanese investors sought higher returns abroad because domestic bond yields were virtually zero. If Japanese government bond yields continue rising, those investors may begin selling foreign assets and bringing their money back to Japan, that would mean selling US treasuries, European government bonds, and other foreign investments, placing upward pressure on borrowing costs across global markets.
Several investment firms have already warned that Japan's bond market could become the catalyst for a broader global bond sell-off. The timing could hardly be worse. Of course, governments across the developed world are already carrying historically high debt burdens. By the way, I recently had an interview with uh the economist Michael Hudson and we discussed the debt burden and how it impacts global economy. So, that was a fascinating interview. I learned so much. I will link it below if you're interested. The United States, of course, continues running trillion dollar deficits. European governments are sharply increasing their military spending and higher energy prices continue to create inflationary pressure. If investors begin demanding significantly higher yields everywhere, governments around the world could face rapidly rising debt servicing costs which would place additional strain on public finances and would slow economic growth.
Now for for many decades, Japan appeared to defy the traditional rules of economics. Massive government debt coexisted with near zero interest rates which allowed policy makers to believe that borrowing could continue almost indefinitely without serious consequences. Well, today we can see that the bond market is delivering a very different message. Inflation has returned, interest rates are rising, investors are questioning fiscal policy, and confidence in Japan's debt is beginning to weaken. The world's largest sovereign debt experiment is entering a completely new phase. It is entering unchartered territory.
The question is no longer whether Japan can continue borrowing. Actually, the real question, I would argue, is how much investors will demand before they're willing to lend. If borrowing costs continue climbing, Japan could become the next major source of global financial instability. Because Japan remains one of the world's largest creditors and one of the biggest foreign holders of US Treasury securities. These developments are actually very very important and they're not going to remain a domestic issue in Tokyo. They will reshape financial markets from New York to London and beyond.
The bond market has issued its warning and I've just discussed it very very briefly and now the world is watching to see whether Japan can navigate this historic transition or whether it marks the beginning of the next global debt crisis. Stay tuned. I will keep you updated on YouTube, Substack, and Patreon. Enjoy the rest of your day and I look forward to seeing you here tomorrow. Take care.